Kosovo Energy Regulatory Office Rule on Distribution System Operator Pricing (DSO Pricing Rule)

Kosovo Energy Regulatory Office Rule on Distribution System Operator Pricing (DSO Pricing Rule) 2011 Adresa: Rr. Hamdi Mramori nr. 1, 10000 Prishtinë, Kosovë Tel: 038 247 615 lok.. 101, Fax: 038 247 620, E-mail: info@ero-ks.org, web: www.ero-ks.org

Contents CHAPTER I General Provisions 4 Article 1 Scope and Purpose 4 Article 2 Definitions and Interpretations 4 CHAPTER II Regulation of DSO Revenues 8 Article 3 General Principles 8 Article 4 Periodic Reviews and Regulatory Periods 8 Article 5 Regular Adjustments 9 Article 6 Extraordinary Reviews 9 CHAPTER III Maximum Allowed Revenues 11 Article 7 General Principles 11 Article 8 Allowed Operating and Maintenance costs 12 Article 9 Allowed Depreciation 12 Article 10 Allowed Return on Capital 12 Article 11 Allowed Cost of Losses 13 Article 12 Pass-Through of Licence Fee 13 Article 13 Excluded Costs 14 Article 14 Smoothing of Allowed Revenues 14 CHAPTER IV Distribution Use of System Charges 15 Article 15 General Principles 15 Article 16 DUOS Charges Approval Process 15 CHAPTER V Connection Charges 16 Article 17 General Principles 16 Article 18 Connection Charges Approval Process 16 CHAPTER IV TRANSITIONAL AND FINAL PROVISIONS 18 Article 19 Official Language 18 Article 20 Changes 18 Article 21 Interpretation 18 Article 22 Repeal 18 Article 23 Entry into force 18 Schedule 1 Maximum Allowed Revenues Calculation 19 Schedule 2 Regulatory Asset Base 23 Schedule 3 Weighted Average Cost of Capital 25 Schedule 4 Excluded Services 27 Schedule 5 Periodic Review Process 29 Schedule 6 Regular Adjustment Process 32 Schedule 7 Extraordinary Review Process 33 2

Schedule 8 Extraordinary Events 35 Schedule 9 Force Majeure Events 36 Schedule 10 Transitional Provisions 37 3

Pursuant to the authority given under Article 8 paragraph 1, subparagraph 1.6, Article 14, paragraph 2, subparagraph 2.16, Article 25 and Article 42, paragraph 1 of the Law No.03/L-185 on Energy Regulator, the Board of the Energy Regulatory Office on a session held on 30.09.2011 has adopted the: Rule on Distribution System Operator Pricing (DSO Pricing Rule) CHAPTER I GENERAL PROVISIONS Article 1 Scope and Purpose 1 This Rule sets: 1.1 The basis for the determination of Maximum Allowed Revenues that may be earned by the Distribution System Operator ( DSO ) in any Relevant Year in order to allow it to recover the reasonable costs of developing, operating, and maintaining the distribution system available to users in accordance with the Law on the Energy Regulator; 1.2 The process by which such Maximum Allowed Revenues shall be reviewed and periodically re-determined; and 1.3 The process by which Distribution Use of System ( DUOS ) charges, used to recover the Maximum Allowed Revenues and the Connection Charges applied by the DSO, are determined. Article 2 Definitions and Interpretations 1 The following terms are used in this Rule and have the following meanings: 1.1 Actual Regulated Revenues means the revenue recovered by the DSO through charges for the provision of Distribution System Services and any other revenue items stipulated by the Regulator, measured on an accruals basis; 1.2 Allowed Investment Plan means the programme of capital projects for the Regulatory Period as approved by the Regulator as part of a Periodic Review; 1.3 Business Days means all working days of the week as defined in Kosovo law; 4

1.4 Connection Charges means the charges applied by the DSO for connecting customers to the Distribution System; 1.5 Distribution Losses means total energy losses occurring in the Distribution System operated by the DSO consisting of (1) technical losses as determined by an engineering estimate and (2) commercial losses defined as energy entering the Distribution System less technical losses less energy billed to customers; 1.6 Distribution System Operator or DSO means the legal entity owner of the Kosovo Distribution System and holder of the Distribution System Operator Licence; 1.7 Distribution System Services means the services which the DSO Licensee is authorised to provide under the terms of the Distribution System Operator Licence granted to it by the Regulator and associated with the making available of a reliable, safe and secure distribution system to persons wishing to use the system; 1.8 Distribution System has the meaning assigned to it under the Law on Electricity; 1.9 DUOS Charges means the set of charges applied by the DSO for the Use of System; 1.10 Economic Asset Lives means the asset lives used to calculate allowed depreciation on the Regulatory Asset Base; 1.11 Efficiency Factor means the efficiency factor defined at Periodic Reviews and applied at Regular Adjustments to determine allowed operating and maintenance costs of the DSO. 1.12 EURIBOR means the European Banking Federation Interbank Offer Rate for Euro deposits for a period equal to 3 months which appears on the appropriate page of the Reuters service at or about 11:00 a.m. Central European Time, or in the event that the Reuter s service, or any successor thereto, no longer provides such information, such other service as agreed by the DSO and the Regulator. For the avoidance of doubt it shall be an annual rate; 1.13 Excluded Service means a service provided by the DSO as part of its licensed activities the costs of which are recovered outside Maximum Allowed Revenues and which includes, but is not limited to, the provision of connections to the Distribution System; 1.14 Extraordinary Adjustment has the meaning given to it in Schedule 7; 1.15 Extraordinary Event has the meaning given to it in Schedule 8; 1.16 Extraordinary Review has the meaning given to it in Article 6; 1.17 Force Majeure Event has the meaning given to it in Schedule 9; 1.18 Licence Fee means the amount payable under the terms of Article 7 of the Schedule of Fees issued by the Regulator and amended; 5

1.19 Loss Allowance has the meaning give to it in Article 11 paragraph 3; 1.20 Loss Sharing Factor has the meaning given to it in Article 11 paragraph 4; 1.21 Materiality Threshold has the meaning given to it in Schedule 7; 1.22 Maximum Allowed Revenues or MAR means the maximum amount that can be recovered in a Relevant Year by the DSO through the DUOS Charge, the revenues from which are regulated under the formulae in Schedule 1 of this Rule; 1.23 Maximum Distribution System Demand means the maximum electricity demand in a year (in MW) metered at entry points onto the DSO s distribution system; 1.24 Metered means any electricity metered quantity, including active energy, reactive energy and demand, as measured by a meter installed for such a purpose under the Metering Code; 1.25 Net Present Value means the method of discounting future cash flows; 1.26 Profiling Factor means the factor defined at Periodic Reviews and applied at Regular Adjustments to allowed operating and maintenance costs, depreciation, and return on capital and is determined as described in Article 7; 1.27 Proposal has the meaning given to it in Schedule 5 paragraph 5; 1.28 Provisional Evaluation has the meaning given to it in Schedule 5 paragraph 8; 1.29 Public Electricity Supplier or PES means the holder of the Public Supply Licence; 1.30 Periodic Review means the review by the Regulator to determine Maximum Allowed Revenues of the DSO for the forthcoming Regulatory Period; 1.31 Regular Adjustment means the mechanical adjustment to Maximum Allowed Revenues undertaken towards the end of each Relevant Year; 1.32 Regulated Units Billed means the aggregate quantity of electricity units billed to Kosovar customers in respect of units supplied to them from the Distribution System; 1.33 Regulated Units Distributed means the aggregate quantity of electricity units distributed through the Distribution System for delivery to Kosovar customers in a Relevant Year metered at exit points on leaving the Distribution System (or where no such meter is installed as otherwise reasonably calculated in accordance with recognised engineering practices); 1.34 Regulator means the Energy Regulatory Office; 1.35 Regulatory Asset Base has the meaning given to it in Schedule 2; 6

1.36 Regulatory Period has the meaning given to it in Article 4 paragraph 3; 1.37 Relevant Year means the period of 12 successive calendar months between Regular Adjustments; 1.38 Statement of Distribution Charging Principles means a statement issued by the Regulator that the DSO s methodologies for setting the DUOS Charge and Connection Charges must be in accordance with; 1.39 Statement of Financial Impact has the meaning given to it in Schedule 7; 1.40 Transmission System Operator or TSO means the holder of the Transmission System Operator licence; 1.41 Transitional Period has the meaning given to it in Schedule 10; 1.42 Unit distributed means a MWh; 1.43 Use of System means the use of the Distribution System for the conveyance of electrical energy from points of entry into the system to supply points for delivery to Kosovar customers; and 1.44 Weighted Average Cost of Capital has the meaning given to it in Schedule 3; and 2 The other terms in this rule shall have the meanings specified in the Law on the Energy Regulator, in the Law on Electricity, or in the Law on Energy. 7

CHAPTER II REGULATION OF DSO REVENUES Article 3 General Principles 1 The DSO shall set DUOS Charges such that within each Relevant Year the revenues that it expects to earn from these charges are equal to Maximum Allowed Revenues (Chapter III) approved by the Regulator. 2 Maximum Allowed Revenues shall be determined as follows: 2.1 Maximum Allowed Revenues shall be set at Periodic Reviews (Article 4): 2.2 Before the end of each Relevant Year, a Regular Adjustment (Article 5) shall be applied which involves mechanical adjustments to Maximum Allowed Revenues for changes in costs that are considered to be outside of the DSO s control; and 2.3 Extraordinary Reviews (Article 6), which involve an adjustment to Maximum Allowed Revenues for material changes in DUOS costs and/or revenues caused by an Extraordinary Event, shall be made as necessary. 3 Transitional provisions given in Schedule 10 shall apply until 31 March 2013. Article 4 Periodic Reviews and Regulatory Periods 1 At Periodic Reviews Maximum Allowed Revenues of the DSO for the following Regulatory Period shall be set. 2 A Periodic Review shall be held prior to each Regulatory Period. 3 Each Regulatory Period shall equal 5 years, except: 3.1 During the Transitional Period as given in Schedule 10; and 3.2 On the mutual agreement of the DSO and the Regulator, a Periodic Period may be shortened or extended. 4 The formulae for calculating Maximum Allowed Revenues at Periodic Reviews are given in Schedule 1. 5 The process for undertaking Periodic Reviews is given in Schedule 5. 8

Article 5 Regular Adjustments 1 At Regular Adjustments the permitted change in Maximum Allowed Revenues shall be calculated. 2 A Regular Adjustment shall be held prior to each forthcoming Relevant Year. 3 The change in Maximum Allowed Revenues at each Regular Adjustment shall be calculated based on the following: 3.1 Indexation of allowed operating and maintenance costs to expected efficiency improvements through an Efficiency Factor; 3.2 Indexation of allowed operating and maintenance costs (after application of the Efficiency Factor), allowed depreciation, and allowed return on capital to inflation; 3.3 Updated forecasts of allowed cost of losses and the License Fee; 3.4 Under or over-recovery of the allowed cost of losses in the current (recently completed) Relevant Year, due to differences between forecast and actual volumes of electricity distributed and wholesale electricity prices, subject to any sharing of such under or overrecoveries between the DSO and users of the Distribution System; and 3.5 Under or over-recovery of Maximum Allowed Revenues in the current (recently completed) Relevant Year, due to differences between forecast and actual electricity distributed on its network and/or differences between forecast and actual Maximum Demand and/or differences between forecast and actual customer numbers. 4 The formulae for calculating Maximum Allowed Revenues at Regular Adjustments are given in Schedule 1. 5 The process for making Regular Adjustments is given in Schedule 6. Article 6 Extraordinary Reviews 1 Extraordinary Reviews shall be triggered by Extraordinary Events, as defined in Schedule 8. 2 At Extraordinary Reviews the impact of the Extraordinary Event on Maximum Allowed Revenues for the remainder of the current Regulatory Period shall be calculated. If the impact is greater than the Materiality Threshold, then an Extraordinary Adjustment to Maximum Allowed Revenues shall be made. The Material Threshold shall be 5% of revenues, unless determined otherwise at Periodic Reviews on the mutual agreement of the DSO and the Regulator. 9

3 The calculation of the impact on Maximum Allowed Revenues and the associated Extraordinary Adjustment shall not account for any factors that are not directly affected by the Extraordinary Event. 4 The Regulator shall also take account of the on-going impacts of Extraordinary Events (that pass the Materiality Threshold) at future Periodic Reviews. 5 The process for undertaking Extraordinary Reviews is given in Schedule 7. 10

CHAPTER III MAXIMUM ALLOWED REVENUES Article 7 General Principles 1 Maximum Allowed Revenues shall be set at such a level that enables the DSO to recover the reasonable costs of providing Distribution System Services, to the extent that those costs are justified and prudently asserted. 2 The reasonable costs of the DSO shall comprise: 2.1 Allowed operating and maintenance costs (Article 8), which shall be adjusted for inflation and the Efficiency Factor at Regular Adjustments; 2.2 Allowed depreciation (Article 9), which shall be adjusted for inflation at Regular Adjustments; 2.3 Allowed return on capital (Article 10), which shall be adjusted for inflation at Regular Adjustments; 2.4 Allowed cost of losses (Article 11), which shall be passed-through based on a Loss Allowance and Loss Sharing Factor at Regular Adjustments; 2.5 The Licence Fee (Article 12), which shall be fully passed-through at Regular Adjustments; and 2.6 The costs of any public service obligations that are not recovered through another mechanism. 3 In determining reasonable costs, the Regulator shall refer to, but is not bound by or limited to: 3.1 Past volume, cost and service quality information relating to the DSO; 3.2 Projected volumes, costs and service quality relating to the DSO; 3.3 Comparisons with similar utilities in Kosovo and in countries elsewhere in Europe, taking account of the similarities between the electricity industry in those countries and that of Kosovo; and 3.4 Comparisons with the costs of similar activities in Kosovo and in countries elsewhere in Europe, taking account of the similarities between the electricity industry in those countries and that of Kosovo. 11

Article 8 Allowed Operating and Maintenance costs 1 In submitting its estimates of fixed and other operating and maintenance costs required to be recovered through Maximum Allowed Revenues for any forthcoming Regulatory Period, the DSO shall only seek to recover any portion or element of such costs which can be attributed to the DSO licensee. 2 Allowed operating and maintenance costs shall only include any proportion or element of corporate costs (of any parent entity or any affiliated entity) that can reasonably be attributed to the holder of the DSO licence using normal and customary accounting practices. 3 At each Regular Adjustments the Efficiency Factor shall be applied to allowed operating and maintenance costs, as per the formulae given in Schedule 1. 4 The Regulator shall set the Efficiency Factor at Periodic Reviews based on the annual efficiency improvement in the operating and maintenance costs of the DSO that can be reasonably expected. For the avoidance of doubt, all expected efficiency gains will be captured in the Efficiency Factor and not double-counted in forecasts of operating and maintenance costs. 5 In setting the Efficiency Factor the Regulator shall refer to, but is not bound by or limited to, the factors specified in paragraph 3 of Article 7. Article 9 Allowed Depreciation 1 Allowed depreciation costs shall be calculated on a straight-line basis as a function of Economic Asset Lives and the Regulatory Asset Base for different classes of assets, as described in Schedule 2. Article 10 Allowed Return on Capital 1 Allowed return on capital costs shall be calculated as a function of the Regulatory Asset Base and the Weighted Average Cost of Capital, described in Schedule 2 and Schedule 3 respectively. 2 Allowed return on capital shall be calculated based on the value of the Regulatory Asset Base at the middle of each Relevant Year (as an average of the opening and closing values of the Regulatory Asset Base). 3 The DSO shall not earn a return on assets financed using capital grants. 12

Article 11 Allowed Cost of Losses 1 The allowed cost of losses shall be the forecast cost of losses to be recovered by the PES from the DSO to compensate for losses on the Distribution System, calculated using the Loss Allowance which shall be set at Periodic Reviews. 2 Maximum Allowed Revenues shall be adjusted for changes in allowed cost of losses at each Regular Adjustment, as per the formulae given in Schedule 1. This adjustment shall: 2.1 Return under or over-recovered allowed costs of losses during the Relevant Year, where these occur for reasons other than the non-achievement of the Loss Allowance; 2.2 Share the difference between the allowed cost of losses and the actual cost of losses incurred by the DSO during the Relevant Year, based on the Loss Sharing Factor which shall be set at Periodic Reviews; and 2.3 Update the forecast allowed cost of losses for the forthcoming Relevant Year, based on the forecast wholesale energy costs of the PES. 3 In setting the Loss Allowance the Regulator shall take into account: 3.1 The outturn level of actual Distribution Losses for the most recent complete period of 12 successive months for which accurate data is available; 3.2 Any expected loss reduction that may reasonably be expected to be obtained based on the Allowed Investment Plan during the Regulatory Period; and 3.3 The level of Distribution Losses in comparable distribution systems in countries elsewhere in Europe, taking account of the similarities between the electricity industry in those countries and that of Kosovo. 4 The Loss Allowance and Loss Sharing Factor shall be sufficient to encourage the DSO to reduce Distribution Losses but not impose costs on the DSO such that its financial position is threatened. 5 The methodology used for measuring the outturn level of Distribution Losses can be changed by the mutual agreement of the Regulator and the DSO. In such cases, the Loss Allowance shall be adjusted to be consistent with the changed methodology, so as to leave the level of loss reductions (expressed in percentage points) expected over the Regulatory Period unchanged. Article 12 Pass-Through of Licence Fee 1 The DSO shall fully pass-through the Licence Fee at each Regular Adjustment. 13

Article 13 Excluded Costs 1 Maximum Allowed Revenues shall not recover costs for the provision of any service (including the provision of electric lines or electrical plant) deemed to be an Excluded Service in terms of Schedule 4 and which: 1.1 Is for the specific benefit of any third party who requests it; and 1.2 Is remunerated under any charges other than charges for use of the Distribution System. 2 The cost of the provision of Excluded Services shall be recoverable by the DSO in line with Schedule 4. Article 14 Smoothing of Allowed Revenues 1 At Periodic Reviews, the Regulator shall smooth the recovery of allowed depreciation and allowed return on capital such that they are constant in each Relevant Year of the Regulatory Period. This smoothing shall be achieved by ensuring that the Net Present Values of smoothed and unsmoothed allowed depreciation and return on capital (during the Regulatory Period) are equal, using the Weighted Average Cost of Capital as the discount rate. 2 At Periodic Reviews the Regulator may also adjust the profile of Maximum Allowed Revenues during the Regulatory Period to minimise significant step changes between the last year of the current Regulatory Period and the first year of the forthcoming Regulatory Period. The Regulator shall give careful consideration to the impact that any profiling will have on the cash flows of the DSO and its ability to provide Distribution System Services. 3 This additional profiling shall be done by applying a Profiling Factor, which may vary for each Relevant Year of the Regulatory Period. In setting the Profiling Factor at Periodic Reviews, the Regulator shall ensure that the Net Present Value of forecast Maximum Allowed Revenues (during the Regulatory Period) is unchanged, using the Weighted Average Cost of Capital as the discount rate. The formulae for applying the Profiling Factor are provided in Schedule 1. 14

CHAPTER IV DISTRIBUTION USE OF SYSTEM CHARGES Article 15 General Principles 1 The DSO shall set DUOS Charges from time to time such that: 1.1 The DSO recovers its allowed revenues that are not recovered from other charges or from Excluded Services; and 1.2 DUOS Charges are in accordance with a methodology developed by the DSO and approved by the Regulator. The methodology shall be in accordance with the Statement of Distribution Charging Principles issued by the Regulator. Article 16 DUOS Charges Approval Process 1 The DSO shall submit to the Regulator its methodology for DUOS Charges and any subsequent amendments to this methodology at least 30 Business Days prior to its proposed date of effectiveness. 2 No methodology or amendments to a methodology shall be effective until approved by the Regulator. 3 The DSO shall have the right to determine the DUOS Charges subject to the requirements Article 15 above. 15

CHAPTER V CONNECTION CHARGES Article 17 General Principles 1 The DSO shall set Connection Charges from time to time such that: 1.1 The DSO recovers its connection costs that are not recovered from other charges; and 1.2 Connection Charges are in accordance with a methodology developed by the DSO and approved by the Regulator. The methodology shall be in accordance with the Statement of Distribution Charging Principles issued by the Regulator. 2 Connection costs shall include the costs of: 2.1 Carrying out of works and provision and installation of electrical plant, lines, meters and other equipment for the purposes of constructing or modifying a connection of an electricity site or customer to the Distribution System in so far as these costs are not otherwise recovered from DUOS Charges; 2.2 The cost of removal of electrical plant, lines, meters and other equipment for the purposes of disconnecting an electricity site or customer from the Distribution System; 2.3 A reasonable rate of return on the capital represented by such costs; and 2.4 The costs of maintenance of electrical plant, lines, meters and other equipment that are not otherwise recovered from DUOS Charges. 3 The boundary between those costs to be recovered from Connection Charges, those to be recovered from DUOS Charges and those to be recovered from other charges shall be defined in the methodology on the determination of Connection Charges. Article 18 Connection Charges Approval Process 1 The DSO shall submit to the Regulator its methodology for connection charges and any subsequent amendments to this methodology at least 30 Business Days prior to its proposed date of effectiveness. 2 No methodology or amendments to a methodology shall be effective until approved by the Regulator. 3 The DSO shall have the right to determine the Connection Charges subject to the requirements of Article 17 above. 16

4 Parties connecting to the Distribution System shall have the rights to refer any dispute over the Connection Charges applicable to them to the Regulator, as provided for in relevant legislation. 17

CHAPTER VI TRANSITIONAL AND FINAL PROVISIONS Article 19 Official Language This rule is issued in Albanian language and shall be translated into Serbian and English language. In the event of discrepancies between versions, the Albanian version shall prevail. Article 20 Changes 1. ERO retains the right to change or modify any provision of this rule. 2. Procedures for amendment or modification of this rule will be the same as for its approval. Article 21 Interpretation If there is uncertainty about the provisions of this Rule, the Board will issue disclosure. Article 22 Repeal This Rule repeals the Rule on Principles of Calculation of Tariffs in the Electricity Sector (Pricing Rule) and Tariff Methodology for the Electricity Sector approved by the Board of ERO on 15 th December 2005, and amendments made on 29 th November 2006 of Tariff Methodology, issued in accordance with Law No.2004/09 on Energy Regulator. Article 23 Entry into force This Rule comes into force upon its adoption by the ERO Board and will be published in the official website of the ERO. Board of the Energy Regulatory Office: Dr. Ali Hamiti, Chairman Përparim Kabashi, Member Blerim Koci, Member 18

SCHEDULE 1 MAXIMUM ALLOWED REVENUES CALCULATION 1 This schedule sets out the formulae for calculating Maximum Allowed Revenues of the DSO. This schedule is intended to complement the principles set out in the main body of the Rules. 2 Maximum Allowed Revenues (MAR t ) shall be calculated at Periodic Reviews and Regular Adjustments using the following formula: MAR t = OPMC t + DEPC t + RTNC t + LSSC t + LICC t + KREV t Where MAR t OPMC t DEPC t RTNC t LSSC t LICC t KREV t is Maximum Allowed Revenues in Relevant Year t is allowed operating and maintenance costs in Relevant Year t is allowed depreciation in Relevant Year t is allowed return on capital in Relevant Year t is allowed cost of losses in Relevant Year t is the Licence Fee in Relevant Year t is the revenue correction factor in Relevant Year t 2.1 Allowed operating and maintenance costs (OPMC t ) shall be calculated at Regular Adjustments using the following formula: OPMC t = OPMC t-1 * (1 + CPI t-1 ) * (1 E t )* (1 P t ) Where OPMC t OPMC t-1 CPI t-1 is allowed operating and maintenance costs in Relevant Year t is allowed operating and maintenance costs in Relevant Year t-1, except for Relevant Year 1 when a value determined by the Regulator at the most recent Periodic Review shall be used is the actual value of inflation in Relevant Year t-1, measured using the Harmonised Indices of Consumer Prices (HICPs) All Items, for the Eurozone published by Eurostat, or any other measure of inflation that the Regulator determines is a better measure of the change in 19

operating and maintenance costs over time and is allowed at a Periodic Review E t P t is the Efficiency Factor in Relevant Year t, which is set at Periodic Reviews is the Profiling Factor in Relevant Year t, which is set at Periodic Reviews 2.2 Allowed depreciation (DEPC t ) shall be calculated at Regular Adjustments using the following formula: DEPC t = DEPC t-1 * (1 + CPI t-1 ) * (1 P t ) Where DEPC t is other allowed depreciation in Relevant Year t, which is smoothed such that it is constant over the Regulatory Period DEPC t-1 is allowed depreciation in Relevant Year t-1, except for Relevant Year 1 when a value determined by the Regulator at the most recent Periodic Review shall be used, which is smoothed such that it is constant over the Regulatory Period CPI t-1 P t is the actual value of inflation in Relevant Year t-1, measured using the Harmonised Indices of Consumer Prices (HICPs) All Items, for the Eurozone published by Eurostat is the Profiling Factor in Relevant Year t, which is set at Periodic Reviews 2.3 Allowed return on capital (RTNC t ) shall be calculated at Regular Adjustments using the following formula: RTNC t = RTNC t-1 * (1 + CPI t-1 ) * (1 P t ) Where RTNC t RTNC t-1 is other allowed return on capital in Relevant Year t, which is smoothed such that it is constant over the Regulatory Period is allowed return on capital in Relevant Year t-1, except for Relevant Year 1 when a value determined by the Regulator at the most recent Periodic Review shall be used, which is smoothed such that it is constant over the Regulatory Period 20

CPI t-1 P t is the actual value of inflation in Relevant Year t-1, measured using the Harmonised Indices of Consumer Prices (HICPs) All Items, for the Eurozone published by Eurostat is the Profiling Factor in Relevant Year t, which is set at Periodic Reviews 2.4 Allowed cost of losses (LSSC t ) shall be calculated at Regular Adjustments using the following formula: LSSC t = LSSA t * REUE t * WHEA t + (LSSCa t-1 LSSCf t-1 ) * (1+ I t ) + (LSSCa t-1 LSAC t-1 )*LSSF t Where LSSC t LSSA t REUE t WHEA t LSSCa t-1 LSSCf t-1 I t LSAC t-1 LSSF t is allowed cost of losses in Relevant Year t is the Loss Allowance, which is a percentage of energy entering the Distribution System, in Relevant Year t is the energy units (in MWh) entering the Distribution System in Relevant Year t is the average wholesale energy cost (in /MWh) as determined using the allowed wholesale energy cost for the PES in Relevant Year t is the actual allowed cost of losses in Relevant Year t-1 (calculated using the Loss Allowance) is the forecast cost of losses in Relevant Year t-1 (calculated using the Loss Allowance) is the interest rate for the Relevant Year t calculated based on EURIBOR plus S%, where S is a value to be determined by the Regulator at Periodic Reviews and which reflects the premium payable by the licensee for short-term loans above the EURIBOR rate is cost of losses actually incurred by the DSO in purchasing energy from the PES as compensation for energy lost on the Distribution System in Relevant Year t-1 (not calculated using the Loss Allowance) is the Loss Sharing Factor in Relevant Year t, which is set at Periodic Reviews 2.5 The revenue adjustment factor (KREV t ) shall be calculated at Regular Adjustments using the following formula: 21

KREV t = (MAR t-1 ARR t-1 ) * (1+ I t ) Where ARR t-1 is the Actual Regulated Revenues in Relevant Year t-1 MAR t-1 is Maximum Allowed Revenues as determined in Relevant Year t-1 I t is the interest rate for the Relevant Year t calculated based on EURIBOR plus S%, where S is a value to be determined by the Regulator at Periodic Reviews and which reflects the premium payable by the licensee for short-term loans above the EURIBOR rate 22

SCHEDULE 2 REGULATORY ASSET BASE 1 This schedule describes the determination of the Regulatory Asset Base for the purpose of calculating allowed depreciation (Article 9) and allowed return on capital (Article 10). 2 The Regulatory Asset Base shall be a regulatory value of the DSO s used and useful fixed assets that are necessary for the provision of Distribution System Services. It shall distinguish between different classes of assets. 3 The Regulator shall define the opening Regulatory Asset Base (as at 1 April 2012) prior to the start of the first Regulatory Period. 4 The Regulatory Asset Base shall be updated at each Periodic Review as follows: 4.1 Allowed depreciation costs during the current Regulatory Period shall be subtracted from the Regulatory Asset Base, calculated on a straight-line basis using Economic Asset Lives; 4.2 Asset disposals during the current Regulatory Period shall be subtracted from the Regulatory Asset Base at their disposal value; 4.3 Allowed capital expenditure during the current Regulatory Period shall be added to the Regulatory Asset Base as from the date when the asset is brought into service and at the cost allowed in the Allowed Investment Plan. Interest during construction shall be capitalised. At Periodic Reviews the licensee may request that the actual rather than allowed cost of an investment be added to the Regulatory Asset Base. The Regulator shall accept the request if the licensee can clearly demonstrate that the difference between allowed and actual costs is due to factors outside of the licensee s control and that its best efforts were made to minimise cost increases. For the avoidance of doubt, the Regulator shall not make any retroactive reduction in revenues earned during the current (recently completed) Regulatory Period to account for differences between the allowed and actual costs. The Regulator shall consider actual costs at future Periodic Reviews as a means of forecasting the cost of future investments; 4.4 If a capital project in the Approved Investment Plan is not brought into service in the current Regulatory Period, its allowed cost shall not be added to the Regulatory Asset Base at the next Periodic Review and any revenues earned from the project in the current Regulatory Period shall be deducted from revenues in the following Regulatory Period; 4.5 Where any maintenance cost is or has previously been included in allowed operating and maintenance costs it shall not be capitalised, nor shall it be included in the Regulatory Asset Base; and 4.6 The Regulatory Asset Base shall be adjusted to take into account inflation over the previous Regulatory Period, using the Harmonised Indices of Consumer Prices - All Items for the Eurozone area as published by Eurostat as the relevant measure. 23

5 Economic Asset Lives for different asset classes shall be used to calculate depreciation on the Regulatory Asset Base. Economic Asset Lives shall be determined at Periodic Reviews such that they reflect the technical lives of assets, except where there is demonstrable reason why the technical life of an asset shall vary from the useful economic life of an asset. 6 Allowed capital expenditure shall be determined at Periodic Reviews based on the Approved Investment Plan for the forthcoming Regulatory Period. The Approved Investment Plan shall: 6.1 Comprise the capital projects reasonably required to provide Distribution System Services; 6.2 Identify each capital project ranked in priority order; 6.3 Show the benefit to network performance that each capital project is reasonably expected to deliver, with reference where appropriate to the meeting of any relevant Distribution System Security, Planning or Operating Security Standard as may be required by the DSO s licence; 6.4 Have regard to any other relevant investment or development plans for the DSO that have been approved by the Regulator (and any differences between these plans shall be identified by the DSO and explained), including the latest 3 Year Investment Plan prepared by the DSO in line with Article 6 of its Licence and as approved by the Regulator; and 6.5 Be developed using an analysis of the discounted costs and benefits of the capital project. 7 The Approved Investment Plan shall be implemented as follows: 7.1 The DSO shall use all reasonable endeavours to ensure the implementation of the Approved Investment Plan in line with its approved timetable; 7.2 If the DSO shall be or is unable to, for reasons beyond its control, undertake a capital project in accordance with the timetable given in the Approved Investment Plan, it shall notify the Regulator. The DSO shall also detail the reasons for the delay and the revised timetable; 7.3 The DSO may at any time apply to the Regulator to substitute an alternative capital project for a capital project in its Approved Investment Plan; so long the alternative project can be shown to be expected to result in the same or greater net benefits to customers (taking account of the expected outcomes and lifetime costs). If the Regulator approves the substitution, the alternative project shall be added to the Regulatory Asset Base at the next Periodic Review. Maximum Allowed Revenues in the current Regulatory Period shall not be adjusted; and 7.4 If the DSO substitutes an alternative capital project for a capital project in its Approved Investment Plan without the prior approval of the Regulator, the Regulator shall consider whether to approve the substitution at the next Periodic Review but is not bound to do so. 24

SCHEDULE 3 WEIGHTED AVERAGE COST OF CAPITAL 1 The Weighted Average Cost of Capital shall be calculated on a pre-tax basis according to the following formulae: WACC = (1 g) * (re) / (1 t) + g * (rd) Where WACC g is the Weighted Average Cost of Capital gearing (debt:debt+equity ratio) re real cost of equity (expressed as a %) rd real cost debt (expressed as a %) t Kosovo corporate income tax rate 2 The gearing (g) shall be a value proposed by the DSO licensee and determined by the Regulator between 0 and 1, and shall represent the share of debt in total financing. The value shall be determined based on a balanced consideration of the current financing mix of the DSO and the financing mix that might be expected to be achievable now and in future taking account of the financing mix of similar utilities internationally. 3 The cost of equity (re) shall be a value proposed by the DSO licensee and determined by the Regulator and calculated using the Capital Asset Pricing Model (CAPM) with the following general formula: rei = rf + βi * ERPm rf ERPm βi risk-free rate equity risk premium applicable to the market as a whole covariance between the returns on the individual equity asset and those of the market as a whole (the equity beta) 3.1 The risk-free rate (rf) shall represent the cost of non-concessionary sovereign debt in Kosovo, in real terms, and shall be proposed by the DSO licensee and determined by the Regulator using evidence on the cost of non-concessionary sovereign debt for Kosovo and/or, where this is unavailable or insufficient, the cost of non-concessionary sovereign debt for countries considered to have a similar credit status to Kosovo. 25

3.2 The equity risk premium (ERPm) shall be proposed by the DSO licensee and determined by the Regulator using evidence on the equity risk premium internationally. 3.3 The beta (βi) shall be proposed by the DSO licensee and determined by the Regulator using evidence on the beta applicable to similar utilities internationally. 4 The cost of debt (rd) shall be the average interest rate of existing long-term loans (exceeding one year) to the DSO, expressed in real terms and weighted according to the value in Euros of each loan. 4.1 The DSO shall be required to procure commercial (non-concessionary) loans through a competitive process, or to demonstrate to the satisfaction of the Regulator that the interest rate of those loans not procured through a competitive process is equal to or less than the prevailing market interest rate at the time the loan agreement was signed. 4.2 Where the Regulator considers that the interest rate of a loan not procured competitively exceeds the prevailing market interest rate, that loan shall be excluded from the calculation of the cost of debt. 4.3 Where the Regulator considers there are insufficient existing loans to provide a reasonable estimate of the actual cost of future debt financing to the DSO, the Regulator may make an adjustment to the actual cost of debt calculated as above. This adjustment shall be made based on: (i) An assessment of the prevailing market interest rate for loans to businesses of similar size, risk and credit status as the DSO. (ii) An assessment of the expected interest rate applied to any future concessional loans to the DSO. (iii) An assessment of the expected mix of commercial (non-concessional) and concessional loans in the debt of the DSO over the coming Regulatory Period. 26

SCHEDULE 4 EXCLUDED SERVICES 1 The DSO may levy a charge in respect of the provision of any Excluded Service, which may include (but not be limited to): 1.1 The carrying out of works the cost of which is required to be reimbursed by a user of the system or a third party (including any necessary reinforcement works or diversionary works) for the purposes of connecting a user to the Distribution System (but only to the extent that the service is not already remunerated under use of system charges described in this Rule); 1.2 The relocating of any electric line or electrical plant (including the carrying out of any associated works) pursuant to any statutory obligation other than one imposed on the DSO under Law on Electricity, the Law on Energy or the Law on the Energy Regulator. 1.3 The moving of any electric line, electrical plant, or metering equipment that forms part of the Distribution System to accommodate the extension, redesign, or redevelopment of any premises on which the asset in question is located or to which it is connected, the cost of which is to be borne by a user of the system or the party requesting the relocation; 1.4 The provision of electric lines and electrical plant to the extent required by any user of the Distribution System to provide a higher degree of security than is required for the purposes of complying with paragraph 2 of Article 10 of the DSO s licence (Distribution System Security and Planning Standards); and 1.5 The provision of any Metering Service that is not already remunerated under any other charge in respect of an Excluded Service. 2 Charges for such Excluded Services shall be set at a level that shall allow the DSO to recover: 2.1 Its reasonable costs incurred in providing the service; and 2.2 A reasonable rate of return on the capital outlay represented by any expenditure incurred by the DSO during the period before payment is received of any amounts due by the person requiring the service in question. 3 Where applicable, such charges shall be determined in accordance with the approved methodology for Connection Charges. 4 In providing a quotation to the person applying for the provision of the Excluded Service, the DSO shall provide such detailed costing as the applicant could reasonably require in order to determine whether the charge is justified. 5 The quotation shall make reference to the role of the Regulator as set out in the Law on the Energy Regulator. 27

6 The DSO shall following the end of each Relevant Year provide to the Regulator details of services provided as part of the Distribution Business and treated as excluded services by the DSO during the course of such year and stating the revenue derived in respect of such services. 7 Where the Regulator considers, in accordance with the principles set forth in paragraphs above,that a service claimed by the DSO to be an excluded service is not such a service, then the Regulator shall issue a direction to the effect that the service is no longer considered to be an exclusive service since the date of issue of this direction or any other date that may be specified in the direction. 28

SCHEDULE 5 PERIODIC REVIEW PROCESS 1 The Regulator shall, in order to promote transparency, publish all submissions, comments, and other documentation received from the DSO or other interested parties in relation to the Periodic Review on its official website within a reasonable time of its receipt and the Regulator shall disclose all material information submitted to it by the DSO, excluding any information that the Regulator acknowledges as being commercially confidential. 2 The Regulator shall initiate the Periodic Review no later than 120 Business Days prior to the start of the forthcoming Regulatory Period. Different timing shall apply during the Transitional Period as given in Schedule 10. 3 The timetable for the overall review process shall be submitted to ERO during the initiation of the review process. 4 The Regulator shall initiate the Periodic Review by notification to the DSO of: 4.1 The years for which actual, estimated forecast data is required; 4.2 The format in which the data is required to be submitted; 4.3 The timetable for submission of the DSO s Proposal for its Maximum Allowed Revenue for the forthcoming Regulatory Period. 5 The DSO s Proposal shall contain the following information and address the following matters (without limitation): 5.1 Actual Regulated Revenues earned during the current Regulatory Period (using a reasonable estimate for the remaining months where necessary); 5.2 Actual costs of providing Distribution System Services during the current Regulatory Period, in line with the definition of costs that was used for calculating Maximum Allowed Revenues; 5.3 The annual report and audited financial statements for each financial year that ended in the current Regulatory Period when these are available as required by the reporting requirements contained in the DSO s licence; 5.4 Actual Maximum Distribution System Demand, Regulated Units Distributed, and Customer Numbers during the current Regulatory Period; 5.5 Forecast Maximum Distribution System Demand, Regulated Units Distributed, and Customer Numbers for the forthcoming Regulatory Period; 29

5.6 Actual Distribution Losses during the current Regulatory Period and forecast Distribution Losses for the forthcoming Regulatory Period; 5.7 Proposed Weighted Average Cost of Capital to be applied in forecasting Maximum Allowed Revenues for the forthcoming Regulatory Period; 5.8 Forecast Maximum Allowed Revenues, reporting each of the allowed cost components separately, for the forthcoming Regulatory Period; 5.9 Any studies commissioned by the DSO relating to any of the matters to be contained in the DSO s Proposal; and 5.10 Any other additional material that the Regulator reasonably considers should be included in the DSO s proposal, so long as the Regulator has notified the DSO a reasonable time prior to the deadline for the DSO s proposal. 6 The DSO shall, to the fullest extent possible, apply the principles and formulae set out in this Rule in preparing its Proposal. It shall disclose any areas where it has not applied these, the reason for not applying them, the reasons supporting the alternative approach, and provide an estimate of the impact of using the alternative approach. 7 The Proposal shall use the most recent available information on the wholesale power costs of the PES applied for the purposes of calculating the loss allowance. 8 Upon receiving the DSO s Proposal, the Regulator shall determine its accuracy, relevance and reasonableness by applying the methodology set out in this Rule, including determining whether the proposed Maximum Allowed Revenues reflects the reasonable costs of providing Distribution System Services. 9 The Regulator shall prepare a Provisional Evaluation within a reasonable time (set forth in the paragraph 3 of this Schedule) on the DSO s Proposal before the start of the forthcoming Regulatory Period, after consulting with the DSO as necessary. The Provisional Evaluation shall set out the Regulator s proposals on the Maximum Allowed Revenues to be recovered by the DSO during the Regulatory Period and the justification for these. The Regulator, in preparing its Provisional Evaluation, may amend, remove or replace any part of the DSO s Proposal as it considers appropriate provided that it shall identify such amendments, removals or replacements and provide justification for these. 10 Following decision on the Provisional Evaluation, the Regulator shall notify DSO and launch a public consultation on its Provisional Evaluation, in accordance with the Law on the Energy Regulator. 11 Following completion of the public consultation within a reasonable time (set forth in the paragraph 3 of this Schedule) before the start of the forthcoming Regulatory Period, the Regulator shall make its Final Decision on Maximum Allowed Revenues for the forthcoming Regulatory Period. Its decision shall be consistent with this Rule. Different timing shall apply during the Transitional Period as given in Schedule 10. 30

12 Maximum Allowed Revenues as provided in the Regulator s Final Decision shall apply from the start date of the forthcoming Regulatory Period. 13 Where more recent information on the allowed wholesale power costs of the PES to be applied for the purposes of calculating the loss allowance, the Maximum Allowed Revenues shall be amended accordingly prior to the start date of the forthcoming Regulatory Period. 14 The DSO may dispute or appeal any decision by the Regulator in accordance with applicable legislation. 31

SCHEDULE 6 REGULAR ADJUSTMENT PROCESS 1 The DSO shall submit the proposed new Maximum Allowed Revenues for the forthcoming Relevant Year to the Regulator at least 50 Business Days before the start of the forthcoming Relevant Year. The DSO shall also include in its submission all relevant documents and evidence including the values relating to all the components of the Regular Adjustment formulae given in Schedule 1 and any other items notified by the Regulator. 2 The Regulator may reasonably require the DSO to further explain its method of calculating the proposed Maximum Allowed Revenues, and if so required, the DSO shall promptly provide to the Regulator any further information or explanations sought. 3 The Regulator shall advise the DSO at least 40 Business Days before the start of the forthcoming Relevant Year whether or not it approves the DSO s calculation of the proposed Maximum Allowed Revenues. 4 If the Regulator approves the proposed Maximum Allowed Revenues, they shall become the Maximum Allowed Revenues for the forthcoming Relevant Year. 5 If the Regulator does not approve the proposed Maximum Allowed Revenues, it shall provide reasons and evidence why, in accordance with this Rule. The Maximum Allowed Revenue shall not be adjusted until the Regulator approves a proposal or provides its own calculation of Maximum Allowed Revenues. 6 Any difference in revenues that arises from incorrect calculations, misreporting of Actual Regulated Revenue, or disputes relating to Regular Adjustment shall be recovered in subsequent Relevant Years. 7 If the Regulator does not advise the DSO within the required period, approval is assumed and the proposed Maximum Allowed Revenues shall become effective on the first day of the following Relevant Year. 8 The DSO shall calculate and notify the resulting DUOS Charges at least 30 Business Days before the start of the forthcoming Relevant Year. 9 The DSO may dispute or appeal any decision by the Regulator in accordance with applicable legislation. 32